China food crisis spreads to foreign brands

Opinion: Watch risks in sector’s China acquisitions

A "temporarily unavailable" sticker masks a picture of chicken nuggets at a McDonald's restaurant in Hong Kong, as food-safety concerns prompt the fast-food chain to pull items at some locations in China and Japan.

HONG KONG (MarketWatch) — For foreign food-and-beverage companies, China’s successive food-safety crises have generally been good news. Not only have they boosted sales as Chinese shoppers flock to more-trusted foreign brands, but valuations have also been lifted by a merger spree as Chinese companies headed abroad in the search of safe food.

But as the latest food scandal puts foreign brands in the dock, perhaps investors need to reconsider the risks of the lucrative Chinese food market.

Last week, reports revealed that a U.S.-owned, Shanghai-based supplier to McDonald’s
MCD, -0.45%
and Yum Brands’s
YUM, -0.87%
KFC in China was found to be selling rotten meat. The issue impacted not just McDonald’s restaurants in mainland China, but also in Japan and Hong Kong, with some outlets forced to pull suspect items from their menus.

The instinctive reaction to this latest food outrage is “Here we go again.” In the recent past, China’s menu of food horrors has included chicken with high levels of antibiotics, rat meat disguised as mutton, rice with toxic levels of cadmium, and baby-milk powder laced with the industrial chemical melamine.

Add in everyday concerns about widespread counterfeiting of products, and you have a situation where confidence in China’s food-supply chain has all but collapsed.

This has lead to some unusual distortions in the market. The extent of cross-border shopping for food essentials means you can expect to hear public-address announcements at Hong Kong International Airport warning departing passengers not to breach limits of baby-formula purchases.

Or if you go out for dinner in China, do not be surprised if the waiter opens the beer, as well as wine, at the table. This gesture is to demonstrate the bottle is genuine and has not been tampered with before it got to the table.

Another distortion has led Chinese consumers to favor foreign fast-food groups. KFC’s reputation for being healthy has little to do with the amount of calories in its deep-fried chicken, but rather that it is less likely to make you ill. This is because Yum, which runs 6,000 stores in China, or McDonald’s, with almost 2,000, are expected to bring the same standards of hygiene and quality control as used in the U.S.

Despite this latest food scandal, it is unlikely Chinese diners will quickly drop this distinction.

The food supplier in question was Shanghai Husi, which is a unit of privately held U.S. food supplier OSI Group. The suspect meat came to light when it was revealed staff had been relabeling sell-by dates after an investigative television exposé by Dragon TV, part of state-owned Shanghai Media Group. Dragon TV even had an employee on film saying it was official company policy to use out-of-date meat.

Previous experience of foreign brands in China getting caught up in food disputes suggests the damage will only be temporary.

In 2012, Yum Brand’s KFC was hit when its supply chain was found to be using chicken with high doses of antibiotics. Danone’s
BN, -0.11%DANOY, -0.52%
Evian and Volvic mineral-water brands were accused of failing to meet national food standards in 2011, an episode which ended with the dumping of 80 metric tons of French water.

Further muddying the situation, there have also been accusations of partisan media coverage against foreign companies over food-safety issues.

Still, whatever the merits of individual cases, these recurring scandals show that reputational risk for foreign F&B companies operating in China is all but unavoidable. By the same measure, it also points to potential risks when Chinese companies are buying foreign food companies.

The largest and most high profile recent acquisition is that of U.S. pork producer Smithfield Foods, which was bought last year in a $7 billion deal by China’s Shuanghui International, now known as WH Group.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.